Analysis of Keppel-KBS US REIT IPO

All examples and stocks quoted here in this article and on the ProButterflyTM site are for learning purposes; it does NOT constitute financial advice or a Buy/Sell recommendation. Contents are reflective of personal views and readers are responsible for their own investments and are advised to perform their own independent due diligence and take into account their own financial situation. If in any doubt about the investment action you should take, you should consult a professional certified financial advisor.

[Update 2018-11-06]: For an analysis of Keppel-KBS REIT's latest rights issue and acquisition of Westpark Portfolio, do head over to our latest article:

[Update 2017-11-07]: A sharp reader pointed out that the peer comparison table against Manulife US REIT did not take into account the ex-rights price adjustment as well as the most recent acquisition of "10 Exchange Place" in New Jersey.

In order to have an accurate DPU and yield calculations, we will need to rely on the next full quarter contribution from the acquisition and ex-rights price adjustment. At this moment, as those figures are not available, we can only do an estimate from the pro-forma information. A new column has been added to show both the pre-rights and ex-rights comparison for Manulife US REIT.

A joint-venture (JV) between Keppel Corporation and KBS Pacific Advisors is seeking to raise $448mil in a Singapore initial public offering of Keppel-KBS US REIT (KKREIT). The KKREIT is a Real Estate Investment Trust (REIT) which draws rental income from 11 office properties across 7 major US cities including Seattle, Austin, Houston and Atlanta. The assets are a mix of prime and sub-urban office spaces.

At the time of writing, KKREIT has just lodged a preliminary prospectus for a listing on the Singapore Stock Exchange (SGX) mainboard. There is a total of 262,772,400 (262.77mil) units on offer at a price of US$0.88 per unit. The IPO and trading of the units will be denominated in USD.

The only other REIT listed in Singapore with major exposure to the US real estate is Manulife US REIT (ManulifeREIT). ManulifeREIT is also denominated in US dollars.

This comes shortly after Cromwell Property Group’s (Cromwell) planned IPO last month. In a turn of events, Cromwell shelved the listing of its Euro-denominated REIT with exposure to a mixed real estate classes across Europe. We covered the Analysis of Cromwell European REIT IPO on our blog site earlier in September 2017.

Based on the indicative timetable, KKREIT plans to open its public offering at 8pm on 02-Nov-2017 till 12pm 07-Nov-2017. Balloting will take place on 08-Nov-2017 and plans to start trading on 09-Nov-2017.

Is the KKREIT IPO worth subscribing to? Let’s take a deeper look.

Indicative Timetable

Source: Keppel-KBS US REIT Preliminary Prospectus

The Offer

The public offer has been summarised in the table below:

Source: Keppel-KBS US REIT Preliminary Prospectus

Peer Comparison

The best peer to compare KKREIT against would be ManulifeREIT as it is also similarly denominated in USD and have office assets in major US cities. However, we broaden our comparison to include IREIT Global as well as Fraser Commercial Trust as well. This is due to IREIT Global also having a mix of prime and sub-urban office spaces in Europe while Fraser Commercial Trust has roughly equal weighting of office assets in Singapore and Australia. In simple Singlish, IREIT Global and Fraser Commercial Trust has exposure to assets in “ang mo” (colloquially meaning Caucasian) countries.

We tabulated the data up with the following comparison table:

Source: Respective Annual Reports and Presentation Slides

We noticed that both ManulifeREIT and IREIT Global trade with a Price/NAV per Unit above 1.0. Averaging out our 3 peers, it seems that KKREIT’s price of US$0.88 is comparable. It would seem to us that the REIT was priced at a slight premium in line with the elevated prices of the current REIT environment.

Edited on 2017-Nov-07: From the dividend yield perspective however, KKREIT is lower than the average of 7.12%. Both ManulifeREIT have higher yields despite having lower gearing and trading at a premium to its NAV per Unit.

Edited on 2017-Nov-07: Based on ManulifeREIT ex-rights price adjustment and post-acquisition of "10 Exchange Place" in New Jersey pro-forma results, we estimate that it would have an approximately yield of 6.68%. This is slightly lower than KKREIT's 6.80% yield.

KKREIT’s manager is also taking its 2018 management fee 100% in units which boost drives to boost the yields. ManulifeREIT similarly is also taking 100% of its fees in units.

Both the weighted average lease expiry and occupancy rates for KKREIT is lower than ManulifeREIT and IREIT Global. This could possibly explain the reason for the lower yields.

We like the fact that KKREIT has a high sponsor interest of 9.5% each Keppel Capital Investment Holdings (KCIH) and KBS SOR Properties LLC (KBS-SORP) totaling 19.0% assuming that the Over-Allotment Option is not exercised. Should this be fully exercised, both their interest will fall to 7.0% each. This is much higher than ManulifeREIT’s 8.08% sponsor interest.

Edited on 2017-Nov-07: From a gearing perspective, KKREIT’s gearing is average., but significantly higher than ManulifeREIT’s 30.8%.

Based on the summary, we could infer that management is pricing the REIT at a slight premium to its NAV per Unit and launching it at this strategic time when Singapore listed REITs are trading at a premium. They are also playing up the potential growth of the REIT’s yield from 6.80% to 7.20% in 2018 and 2019 respectively by anticipating growth in occupancy rates in 2019. Yields are temporarily boosted from the manager taking its 100% of its 2018 fees in units.

We like the fact that the manager’s fee is paid as a percentage of the distributable income and the performance is linked to growth in the distributions. This aligns the interest of the REIT manager with unitholders. The management fee of 10% of distributable income and performance fee of 25% of the difference in distributable income is the same as ManulifeREIT management fee policy.

We also think that the gearing at 36.0% for a newly listed REIT is a little high and could limit the speed that it could grow through acquisitions. It doesn’t leave much debt headroom left to grow without a rights issue or perpetual security issue sometime in the foreseeable future.

A More Detailed Look at KKREIT

Sponsors, Real Estate Portfolio and Growth Opportunities

Source: Keppel-KBS US REIT Preliminary Prospectus

KBS is a commercial real estate investment manager in the US headquartered in California. It has a large footprint of commercial real estate under management and ranked as the eleventh largest US owner of office properties globally. It also has a track record of launching 30 different institutional investment funds and seven publicly registered non-traded REITs.

KBS has a strong network which would likely provide a strong sponsorship pipeline of properties which KKREIT could acquire in the future to feed its growth. However the higher gearing of 36% may limit its speed of acquisition as it needs to raise committed funding before an acquisition.

Source: Keppel-KBS US REIT Preliminary Prospectus

KKREIT has 11 office assets across 7 major US cities and are a mix of prime and sub-urbance office spaces. The class A assets contribute about 69% of the gross rental revenue while class B contributes the rest. The rental source across these various classes are spread out fairly evenly.

With regards to the geographical spread, Seattle contributes the highest rental income of 32% while Houston is the second highest at 21%. The geographic profile is also evenly spread with no heavy concentration is any particular city.

However as all the assets are in the US, a country while adverse economic impact (similar to the Global Financial Crisis of 2008) could impact all the assets as businesses scale down their rental cost.

Lease Profile

Source: Keppel-KBS US REIT Preliminary Prospectus

KKREIT has a very well distributed least profile with not more than 20% of the leases expiring in any single year. This is good as it reduces the risk of too many leases expiring in the same year which may overburden the renewal process for the manager. The evenly distributed lease profile also provides some certainty and predictability in the rental income. Any adverse economic situation in a particular year will also not significantly affect their lease renewals.

Source: Keppel-KBS US REIT Preliminary Prospectus

Based on the occupancy rate of its current assets, we can see that their current occupancy rate of 88.1% is slightly lower than the market average of 90.7%. This is due to a few assets primarily in Austin, Houston and Seattle (including Bellevue) underperforming relative to the market occupancy. Seattle being the largest contributor of rental income, their underperformance will certainly be a drag on the overall occupancy rate relative to the market average.

It would seem to us that the REITs may have bundled some high quality assets with some which are sub-par. Therefore the ability for the REIT manager to ensure that the occupancy of its Seattle and Seattle-Bellevue assets meet at least the market average is crucial.

Debt Profile

Source: Keppel-KBS US REIT Preliminary Prospectus

The debt maturity profile of KKREIT is a little concentrated in the 2021 and 2022 with 50% maturing in each year. However with a long debt tenure of 4.5 years, it has no debt refinancing obligations until 2021. This gives some level of certainty and predictability to the REIT’s distribution.

KKREIT’s average effective interest rate is approximately 3.35% per annum, which seems fairly average.

The interest coverage is at 5.3x which is fairly comfortable.

In the preliminary prospectus, it was mentioned that KKREIT manager “will enter into interest rate derivative hedging instruments to hedge a substantial amount of its borrowings for the acquisition of the IPO Portfolio, to mitigate the risk of exposure to interest rate volatility”. This is a good sign as the management is actively managing its interest rate risk.

Tenant Portfolio

Source: Keppel-KBS US REIT Preliminary Prospectus

We note that KKREIT has a fairly evenly distributed tenant profile with no concentration risk is any particular industry. This would mitigate the impact of any adverse crisis in a specific industry.

The top 10 tenants make up about 22.3% of the rental revenue. Therefore the REIT is not heavily dependent on any particular tenant.

Exchange Rate Risk

The USD is now a close to a 2 year low. It has weaken significantly against the Singapore dollar since the start of the year.

However with expectations that the US FED will hike the interest rates in the US in December 2017, we could perhaps expect the USD to strengthen over the months.

As Singapore investors who are converting their funds into USD for this investment, exchange rate and interest rate risk will always be present.

Valuation

Discounted Dividend Model

We have chosen to a value KKREIT based on Discounted Dividend Model (DDM). The projected growth rate on the preliminary prospectus is 5.8%, however we doubt that the REIT is able to continue this growth rate and therefore decided to instead use a 2.5% growth rate to be conservative.

We have also chosen a discount rate of 3.5% to 4.0% as this represents the premium that we demand over the risk free rate of the CPF ordinary account interest rate of 2.5%.

We have also chosen to a flat 15-year period to sum with no terminal value. We believe that these assumptions account for both the benefits and stability that KKREIT brings as well as the risk that investors take on.

Using the dividend discount modal, we get a range between US$0.83 and US$0.86. The upper range of the fair value at US$0.86 is just 2c lower than the range offer price of US$0.88 in the offer.

Peer Comparison Model

Based on the comparison against ManulifeREIT and the average of its peers, we conclude that the valuation is priced with a slight premium above its NAV per Unit.

Together with the information from the Discounted Dividend Modal, we think that the REIT priced slightly above its fair value for both the Price/NAV per Unit perspective and Dividend Discount Modal.

We think that that it might be better to wait for a correction in the Singapore REIT markets to pick up KKREIT at below its NAV per Unit, or towards the lower end of the DDM fair value range.

Comfortable average interest rates of 3.35% with good interest coverage at 5.3x

Potentially riding on strengthening USD

Top-10 tenants make up 22.3% of rental income, not heavily dependent on any tenant

What we see as risk factors to KKREIT’s investors:

High initial gearing of 36% limiting the speed that it could grow through acquisitions

Lower occupancy rate compared to the market average especially in Seattle which is its major rental income source

Lower yield compared to ManulifeREIT despite ManulifeREIT having lower gearing and trading at a premium to its NAV per Unit

Concentration risk as all assets are in major US cities

Debt refinancing obligations concentrated in 2021 and 2022

Priced at a premium to NAV and Discounted Dividend Model fair value

We had performed 2 methods of valuation for KKREIT and we summarised our fair value price estimations based on the different methods below:

Discounted Dividend Model Method: US$0.83 and US$0.86

Peer Comparison Method: US$0.83

KKREIT certainly has some strong points, but we would probably stay away from the IPO and watch on the sidelines how the price action performed in the near term after going public. If the prices falls below its NAV of US$0.83, we might consider adding it to our existing REIT portfolio. We are not in a hurry to buy into this REIT as we are already holding other REITs in our portfolio with 7.0% to 7.5% yields at our purchase price.

Price at $488, this is by far the most comprehensive REITs workshop available in Singapore. We focus on REITs can deliver both capital appreciation and sustainable dividends. During the workshop, we focus our learning with practical examples of real world REITs case studies both local and overseas. This is to ensure that attendees can immediately apply what they learn.

The views and opinions expressed herein are those of Tam Ging Wien (“the author”) and do not necessarily reflect the official policy, position or view of the author’s employer, organization, committee or other group(s) or individual(s).

The author does not intend to subscribe to the Singapore Public Offer of Keppel-KBS US REIT.

The author at time of writing does not hold any stake in Keppel Corporation Ltd or KBS.

Didn't find what you were looking for? Subscribe to our free weekly newsletter where we send the best stories we read this week, stock tips and even special offers for subscribers. We don't want you to miss out.

Subscribe for our exclusive weekly newsletter. We do not share that content on the blog. It includes in-depth analysis on equities, IPO's & REITs. Join our exclusive inner circle today and get an edge in your investing!